TaxTMI 
TaxTMI 
2019 (8) TMI 31
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....ULING, MAHARASHTRA BRIEF FACTS OF THE CASE A. The Appellant is a non-banking financial company and is inter alia engaged in providing various types of loans to the customers such as auto loans, loans against the property, personal loans, consumer durable goods loans, etc. B. The Appellant, inter alia, enters into agreements with borrowers/customers for providing loans to them. The loan agreements provide for repayment of the outstanding dues/ Equated Monthly Installments (EMI) through cheque/ Electronic Clearing System CECS')/ National Automated Clearing House ('NACH') or any other electronic or clearing mandate. The illustrative copies of loan agreement entered into between the Appellant and the customers have been enclosed with the Appeal. C. The installment of a loan is computed taking into consideration the amount of loan, rate of interest, duration for a loan etc. Generally, EMI paid by the customer is a fixed amount paid at a specified date. EMI includes the amount of interest and the principal amount. D. In case of delay in repayment of EMI by the customers, the Appellant collects penal/default interest (hereinafter referred to as 'penal interest') as an additional inte....
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....ive, whether the activity of collecting penal interest by the Appellant would amount to a taxable supply under the GST regime?" H. The AAR passed the Order No. GST-ARA-21/2018-19/B-24 dated 06.08.2018 = 2018 (12) TMI 1154 - AUTHORITY FOR ADVANCE RULING, MAHARASHTRA (hereinafter referred to as 'impugned order'), holding that the penal interest charged by the Appellant amounts to supply of services under Sr. No. 5(e) of Schedule II to the CGST Act, and is therefore liable to GST. I. Aggrieved by the impugned order dated 06.08.2018, the Appellant has filed this appeal, inter alia, on the following grounds which are urged without prejudice to each other. GROUNDS OF APPEAL 1. The impugned AAR order is a non-speaking order and is liable to be set aside on this ground alone. (i) Without prejudice to the submissions that the penal interest is an additional interest on loan, such penal interest is liable to be included in the value of main supply under Section 15(2)(d) of the CGST Act, and therefore, any treatment given to the main supply shall be given to the penal interest, and hence, shall be exempt from GST. (ii) In any case, the penal interest charged by the Appellant is in the n....
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....of CGST & Central Excise v. M/s. Development Credit Bank Ltd., 2018-TlOL-2313-HC-MUM-CX 4. It is an undisputed fact that the Appellant is an NBFC which is engaged in providing various types of loans to the customers such as auto loans, loan against property, personal loan, consumer durable goods loan, etc. Further, it is also undisputed that interest on loans have been kept outside the levy of GST, under Serial No. 27 of the Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017. The relevant portion of the said Exemption Notification is reproduced herein below: Sl.No. Chapter, Section, Heading Group or Service Code (Tariff) Description of Services Rate (per cent.) Condition (1) (2) (3) (4) (5) 27 Heading 9971 Services by way of- (a) extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount (other than interest involved in credit card services); Nil Nil 5. In view of the above, it is submitted that services of providing loans are exempt, in so far as the consideration of the said services is represented by way of interest. It is therefore submitted that any amount which is charged as interest is no....
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....es of section 34. In Dr. Shamlal Narula v. CIT [1964] 7 SCR 668 = 1964 (4) TMI 10 - SUPREME COURT, this Court held that interest is paid for the deprivation of the use of the money. The essence of interest in the opinion of Lord Wright, in Riches v. Westminster Bank Ltd. [1947] 1 All ER 469, 472, is that it is a payment which becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have made if he had the use of the money, or, conversely, the loss he suffered because he had not that use. The general idea is that he is entitled to compensation for the deprivation; the money due to creditor was not paid, or, in other words, was withheld from him by the debtor after the time when payment should have been made, in breach of his legal rights, and interest was a compensation whether the compensation was liquidated under an agreement or statute. A Division Bench of the High Court of Punjab speaking through Tek Chand, J. in CIT v. Dr. Sham Lal Narula AIR 1963 Punj. 411 = 1962 (1) TMI 64 - PUNJAB HIGH COURT thus articulated the concept of interest "The words 'interest' and 'compensation' are sometimes used inter....
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....at all. Applying Act 4 of 1938 to the present contract it is clear that the principal is Rs. 2500. The only payment was an open payment of Rs. 150 made on 23rd July 1931. The whole of the interest as on 1st October 1937 is cancelled and the creditor is entitled to Rs. 2350 with interest at 61/4 per cent. per annum from 1st October 1937. The appellants are entitled to their costs here and in the Court below." Similarly, in the case of V. Srinivasachariar v. Conjeevaram Hodgsonpet Dharamarakshaka Nidhi Limited, 1940 AIR (Mad) 937 = 1940 (8) TMI 32 - MADRAS HIGH COURT, the Hon'ble Madras High Court held as under: "3...........I proceed therefore to such an examination and I find that towards the sum of Rs. 1,500 borrowed in February, 1927, a sum of Rs. 1,396-3-3 has been credited as part repayment. The suit is for the balance, namely, Rs. 807-13-2 and the accounts have been closed shortly before the filing of the suit in March, 1932,, The result then is that for a debt of Rs. 1,500 incurred in February, 1927, a total sum of Rs. 1,396-3-3 plus Rs. 807-13-2, that is, Rs. 2,204-0-5 has to be repaid and this repayment is related to a period of just over five years. Of this sum, Rs. 1,5....
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.... in the form of an interest or a discount. This entry would not cover investments by way of equity or any other manner where the investor is entitled to a share of profit. Illustrations of such services are - * ........... * Providing a loan or overdraft facility or a credit limit facility in consideration for payment of interest. * Mortgages or loans with a collateral security to the extent that the consideration for advancing such loans or advances are represented by way of interest. * .............." 13. On conjunctive perusal of the above, it can be understood that "interest" represents the time value of money, and any amount received in lieu of usage or retention by one person of a sum of money belonging to another is nothing but interest only. 14. In the present case, the Appellant is primarily engaged in the business of lending/financing. As a consideration for lending/financing, the Appellant charges interest from the customers at a particular rate, for the period for which such loan is granted. The principal and interest amount on such loan is repaid by the customers by way of equated monthly installments (hereinafter referred to as 'EMI') over the tenure ....
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.... purposes of the GST law, and hence, the same shall be exempt from GST. 18. However, the Ld. AAR in the impugned AAR order has held that the penal interest is not interest on loans. In this regard, the Ld. AAR has recorded a finding that the penal interest has been termed as 'penalty' in the loan agreements entered into by the Appellant. 19. It is submitted in this regard that the additional interest for the period of default has been variedly termed in the loan agreements as 'penal interest' / 'default interest' / 'late payment penalty', however, the same does not change its nature from being 'interest' only. It is a settled principle in law that the nomenclature alone would not determine the nature of transaction. In this regard, reliance is placed on the decision of the Hon'ble Supreme Court in the case of Moped India Limited reported at 1986 (23) ELT 8 (SC) = 1985 (2) TMI 42 - SUPREME COURT, wherein it was held as under: "6. . ...Now it is true that this amount allowed to the dealers has been referred to in the agreement as commission but the label given by the parties cannot be determinative because it is, for the court to decide whether the amount is trade discount or not....
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.... the interest component of the EMI. 24. The above findings are based on an incorrect understanding of the facts of the present case. In this regard, it is relevant to note that the Ld. AAR has not disputed that the interest which is factored in EMI fits into the meaning and scope of interest of loans, therefore, the rate at which such interest is payable is not relevant to determine the nature of such transaction. The Ld. AAR has failed to understand the commercial reality of the financial transactions. It is submitted in this regard, that there are many ways of determination of the rate of interest, which includes flat interest rate, reducing balance rate, etc. However, in any case, the interest is, in effect, the consideration for the usage of money for a certain period of time, therefore, even if the interest is computed at flat rate, (i.e. interest for the entire tenure divided by the number of instalments), the same is charged only for the period of usage of money. Further, the rate of interest on loans, amongst other factors, is a matter of negotiation between the lender and the customer, but the same in no manner affects the nature of such interest. For instance, whether a ....
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....e, the above mentioned findings of the Ld. AAR are erroneous and bad in law. 27. In view of the above discussions, it is submitted that Penal Interest collected by the Appellant is additional interest only, therefore, any treatment given to the main consideration, i.e. interest on loans, shall also be equally applicable to the penal interest. Hence, the penal interest shall be exempted from payment of GST under the Exemption Notification. 28. In this regard, reference is also made to UK VAT Notice 701/49: Finance issued under the UK VAT law, wherein the charges levied for deferment of payment beyond the time of supply have been treated as consideration for an exempt supply of credit. The relevant portion of the said UK VAT Notice is extracted herein below: "4.5 Deferred payments-You may allow customers to defer payment but make an extra charge for allowing them to do so. If the charge relates to periods before and up to the time of the supply (see VAT Notice 700: the VAT Guide) it is not a charge for credit, but is further consideration for the supply of the goods or services. Alternatively, where you agree to defer payment beyond the time of supply and make an additional char....
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....w of Section 15(2)(d) of the Act, the penal interest levied for delayed payment of loan dues/EMl, being an interest/penalty for delayed payment of consideration, is to be included in the value of loans, which is nothing but interest only. Therefore, the penal interest so levied by the Appellant would be treated at par with interest, and any treatment given to the main consideration (i.e. interest) shall also be equally applicable to such amount (i.e. penal interest). Hence, the penal interest would be exempt from GST under Serial No. 27 of the Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017. In any case, the penal interest charged by the Appellant is in the nature of penalty or liquidated damages for breach of contract, which does not amount to consideration for any contract, and therefore, there cannot be any supply of service. 34. Without prejudice to the above submissions, in any case, if the penal interest is not treated as interest on loan, then, the same shall be treated either as penalty or as liquidated damages for the default committed by the customers, which is not leviable to tax in GST law. 35. Under the GST regime, the taxable event is the 'supply' of g....
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...., (b) or (c) of Section 7(1) of the CGST Act. In any case, the penal interest collected by the Appellant is also not covered under clause (d), as explained in detail in the submissions made below. 39. In this background, it is necessary to understand whether the penal interest collected by the Appellant constitute a supply for consideration under clause (a) of Section 7(1). In this regard, it is relevant to refer to the definition of the term 'consideration given in Section 2(31) the CGST Act as under: "(31) "consideration" in relation to the supply of goods or services or both includes- (a) any payment made or to be made, whether in money or otherwise, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government; (b) the monetary value of any act or forbearance, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government:" 40. Since....
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....e contract. 46. The provisions of Section 73 and 74 are extracted herein below for reference: "73. Compensation for loss or damage caused by breach of contract. - When a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it. 74. Compensation for breach of contract where penalty stipulated for. - When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named or, as the case may be, the penalty stipulated for. Explanation. - A stipulation for increased interest from the date of default may be a stipulation by wav of pena....
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....levant to understand whether the amounts recovered in the nature of damages or penalty amounts to supply. The same has been explained in the submissions made herein below. 54. It is submitted that payment of liquidated damages or penalty is not a consideration for any supply, as they are merely damages for the breach of contract. It is submitted in this regard that the stipulation for payment of damages upon breach of contract does not constitute a separate contract; it is a part of the original contract only. The payment of damages arises on account of breach of the primary contract, and it would be an incorrect interpretation to say that such payment is a consideration for any other contract. 55. Without prejudice to the submission made in Para B. 13 above, in the present case, there is only one contract between the Appellant and the borrower, which is the agreement for loan, for which consideration is payable by the borrower in the form of interest. The penal interest is payable by the borrower, only upon the breach of conditions of the same contract, and therefore, such payment does not constitute a second contract. Therefore, the payment of penal interest by the borrower can....
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....clause as under: (i) agreeing to the obligation to refrain from an act; (ii) agreeing to the obligation to tolerate an act or situation; (iii) agreeing to the obligation to do an act. 62. It is submitted that the expression "agreeing to the obligation" is a prefix to all the three entries, viz. 'to refrain from an act', 'to tolerate an act or a situation', and 'to do an act'. Therefore, to attract the above said clause, there must be an agreement to the obligation in respect of any of the three entries. In other words, the act of tolerance requires the wilful agreement of certain situations wherein the party agrees to suffer or restrain from doing something for some pre-fixed consideration. 63. In the present case, there is no agreement between the Appellant and the borrower to tolerate the default committed by the borrowers. The only agreement between the Appellant and the borrower is in respect of agreement for loan, for which consideration is payable by the borrower in the form of interest. The penal interest is payable by the borrower, only upon the breach of such contract, and therefore, such payment does not constitute a second contract. 64. However, the Ld. AAR has....
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....tion, (n.) 1.A legal or moral duty to do or not do something. The word has many wide and varied meanings. It may refer to anything that a person is bound to do or forbear from doing, whether the duty is imposed by law, contract, promise, social relations, courtesy, kindness, or morality. 2. A formal, binding agreement or acknowledgement of a liability to pay a certain amount or to do a certain thing for a particular person or set of persons; esp., a duty arising by contract. 3. Civil law. A legal relationship in which one person, the obligor, is bound to render a performance in favor of another, the obligee." * Oxford Dictionary: "obligation > n. 1. an act or course of action to which a person is morally or legally bound. the condition of being so bound. 2. a debt of gratitude for a service or favour." 67. In view of the above, it is submitted that the word 'obligation' can be understood to be an act or course of action to which a person is morally or legally bound. It is a bond or tie, which constrains a person to do or suffer something and it implies a right in another person to which it is correlated. As defined in the Specific Relief Act, 1963, 'obligatio....
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.... are not taxed. 73. It is further submitted that internationally, the damages received by way of compensation for termination or breach of a contract are not treated as a supply and therefore not subjected to GST/VAT levy. 74. In Australian Law, the GST is levied on supply under 'A New Tax System (Goods and Services Tax) Act, 1999'. The term 'supply' is defined under Section 9(10) of the said Act. Clause (g) of sub-section (2) is pari materia the provisions of clause (e) of Entry 5 of Schedule II to the CGST Act, which reads as under; "9-10 Meaning of Supply (1) A supply is any form of supply whatsoever. (2) Without limiting subsection (1), supply includes any of these: ..... (g) an entry into, or release from, an obligation: (i) to do anything; or (ii) to refrain from an act; or (iii) to tolerate an act or situation. 75. In the above context, reference is made to GSTR 2001/4, issued by the Australian Tax Office (ATO), explains the GST treatment of court orders and out-of-court settlements. In the said ruling at Para 73, it has been clarified that the damages are the most common form of remedy arising out of the termination or breach of contract. The damage, loss....
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.... and the payment of the fine or penalty is therefore not a consideration for a supply and hence not leviable to GST. It has been clarified in the above GSTD that if the true nature of fine or penalty is a punishment and/or to act as a deterrent, it does not accord with that nature to suggest that there is a supply to the member in return for its payment. 79. Reference is also made to the New Zealand case S65 (1996) 17 NZTC 7408, wherein it has been held that an association, in accepting the payment of fine or penalty, does not enter into an obligation with the particular member to tolerate the misconduct, but rather is fulfilling its obligation to all members to enforce the rules. The member does not gain rights additional to those which are already enjoyed by virtue of being a member. That is, upon payment of the fine or penalty, the member continues to enjoy the same rights and privileges and it follows that the association is required to continue to provide the benefits of membership. In this sense, it cannot be said that the association 'makes' a supply where it already has a pre-existing obligation to continue to provide the benefits of membership. 80. Reference is further m....
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....n obligation to tolerate an act or situation. 85. Hence, by applying the above rulings, it can be concluded that the penal interest collected by the Appellant in the present case, being penalty/liquidated damages for breach of contract, are not taxable, as the same does not amount to consideration for any supply. Personal Hearing 86. A personal Hearing in the matter was conducted on 07.03.2019, wherein Shri Sandeep Sachdeva, Advocate, representative of the Appellant, reiterated their written submissions. Shri Harshal Kotale, Dy. Commissioner of State tax, appearing as jurisdictional officer, reiterated the submissions, which had been made earlier before the Advance Ruling Authority. Discussion and Findings 87. We have gone through the record, the facts of the case and have also taken on record the written and oral submissions made by the appellant as well as by the department. We have also gone through the impugned order issued by the Advance Ruling Authority, according to which the quantum of penal charges / penalty defined in the loan agreement is being collected by the Appellant for the reason that the customers have delayed the payment of EMI and the Appellant has tolerate....
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....eans interest levied by BFL from the due date till payment on happening of any event of Default as set out in clause 3 (iv) of this agreement. q. "Penal Charges" mean and include over-due char es on non-payment of installment on the due date. r. .........................................." 3. The Borrower agrees and confirms that: (iv) BFL is entitled to levy penalty as follows on default: (b) for continuing non-payment of amount due, a penalty not exceeding 3% per month on amount due calculated on pro-rata basis from due date till actually paid as per clause B of the schedule. 16. In respect of any delayed payments, without prejudice to all other rights of BFL under this agreements: a. BFL shall be entitled to recover a sum described in 'A&B' of the schedule. b. ............................... SCHEDULE FORMING PART OF AUTO LOAN AGREEMENT A. B. Penal Charges a. Bounce charges . b. For continuing of non-payment of amount due, a penalty not exceeding 3% per month on amount due calculated on pro-rata basis from due date till actually paid as per clause B of the schedule. From the nomenclature adopted by appellant, it is evident that the agre....
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.... a deposit, claim or other similar right or obligation) but does not include any service fee or other charges in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised" 91. We have observed that when the term "means" is used while defining an expression, it gives a restrictive meaning to the expression defined. There is no doubt that the definition is not inclusive of specifically mentioned therein service fees or other charges. The agreed amount payable by the borrower for delay in payment of EMI cannot be characterized as 'interest payable in any manner'. The penalty / penal charges recovered by the appellant for delay in payment of EMI are though in respect of money borrowed by the customers, get covered by the term other charges used in the said definition. This further proves that the intention of the legislature is to exempt only that 'interest' which is covered under term 'interest' defined in clause 2 (zk). In view of the above background, the penalty / penal charges charged/collected by the appellant does not qualify as "interest thereby do not qualify for exemption under entry 270f the Notification No. 12/2017-Cen....
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....ement is not the only deciding factor to construe it as penalty / penal charges, but the nature of it as defined in agreement is important- the nature being that the appellant is entitled to recover and the borrower agreed to pay it. One of the important test to determine whether the levy is penal in nature is to see whether it is for the non-compliance of provisions and if any criminal liability or prosecution is provided, the levy is surely penal in nature. The said test is surely passed by the penalty / penal charges in the present case as consequences provided therein agreement for non-compliance of it may be prosecution under the Negotiable Instruments Act. Hence, the penalty levied by the appellant cannot be termed as 'additional interest' but are penal charges. 94. The Appellant have also relied upon the various overseas rulings, viz. UK VAT Notice 701/49, GSTR 2001/4, GSTR 2001/4, GSTR 2003/11, GST Determination No. 2005/6, to substantiate their contention that the charges for deferment of payment are treated as consideration for exempt supply of credit. As regards these international ruling pronounced in overseas countries, we are of the view that the aforementioned rulin....
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....ation covenants contained in this agreement, and also if: a. Any default shall have occurred in payment of Monthly Installment or any part thereof and / or in payment of any amount due and payable to BFL in terms of this agreement. 26. Remedies for Default: The following are without prejudice to the other as also to other rights and remedies under law or in enquiry or under this agreement: a. BFL has full right to recall the entire loan and proceed against the borrower. b. In case of default by reason of PDCs, ECS Mandate / ADM / any other electronic or other clearing mandate transaction being dishonored, BFL shall initiate legal proceeding under section 138 of the Negotiable Instrument Act 1881 for dishonor of cheques issued by borrower or under Payment and Settlement System Act, 2007. c. BFL shall be entitled to take possession of the product without prejudice to any other remedy available with BFL ........ 97. From the above referred clause 25 of the agreement it is clear that the default in payment of EMIS is hereby deemed to be default under the provisions of agreement entered between appellant and customers. From the above referred clause 26, on any default or br....
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....ubmission with reference to the provisions of scope of supply, the appellant submitted that the clause (a), (b) and (c) of section 7 of CGST Act define the scope of supply, whereas, clause (d) classifies certain activities specified in Schedule II as supply of goods or supply of services. The said section is reproduced herein below: "Section 7. (1) For the purposes of this Act, the expression "Supply" includes:- (a) all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made [or a consideration by a person in the course or furtherance of business; (b) import of services for a consideration whether or not in the course or furtherance of business: (c) the activities specified in Schedule l, made or agreed to be made without a consideration and (d) the activities to be treated as supply of goods or supply of services as referred to in Schedule II. From above said scheme of scope of supply it is evident that Clause (a) covers all kinds of supply of goods or services made or agreed to be made for a consideration by a person in the course or furtherance of business. The wording provided....
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....unt of the delay by the borrower and the borrower is under the contractual obligation to pay the said amount. As regards this contention of the Appellant, it is opined that as long as the Appellant is tolerating the delay in payment by the borrower, this act of tolerance would be construed as supply of service in terms of the provision of Section 7 (1) (a) of the CGST Act read with the entry 5 (e) of the Schedule II to the CGST Act, 2017. The bounce charges are recovered by the appellant for tolerating the act of delay and it is nothing but consideration. It is clearly from the meaning of the "consideration provided under Section 2(31) that it includes the impugned charges. The definition is reproduced herein:- "consideration" in relation to the supply of goods or services or both includes- (a) any payment made or to be made, whether in money or otherwise, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by another person but shall not include an subsid given by the Central Government or a State Government: (b) the monetary value of any act or forbearance, in respect of, in response to, or for the in....
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....separated by semicolon. It is evident from the construction of the said entry that it contains three expressions and that all three expressions namely "agreeing to the obligation to refrain from an act; or to tolerate an act or a situation: or to do an act" are separated with semicolon followed by word "or". It shows that semicolon and "or" separates the above said three expressions showing that they are not inextricably connected. Therefore, the theory of interpretation coined out by the appellant by connecting group of words of first expression "agreeing to obligation" with rest of two expressions is not the correct legal interpretation. 104. The relevant extract of Hon. Supreme Court judgment in the case of PIL of Shri. Jayant Verma Vs. Union of India, dated 16/02/2018 = 2018 (2) TMI 1326 - SUPREME COURT related to the expressions separated by semicolon is as under: "We are afraid we cannot agree for several reasons. firstly, purely grammatically, a semicolon separates the two expressions showing that they are not inextricably connected......... Entry 5, List III deals with seven completely different subjects, all banded together under Entry 5 and separated by semicolons, m....